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Groupon Nightmares (and How to Avoid Them)

Groupon might seem like great advertising, but it can spell disaster for unprepared small businesses.

The Groupon coupon service is hot right now -- not only with customers who love getting deep discounts, but also with businesses looking to appeal to the site's vast database of potential clients.

Groupon and other social-coupon sites (such as BuyWithMe, LivingSocial, SocialBuy, and Tippr) offer deals with a catch: For a deal to become valid, a certain number of people must first purchase it. That way, Groupon makes a certain amount of money, businesses are guaranteed a certain number of customers, and customers get deep discounts. Supposedly it's a win-win-win situation.

But small-business owners should be careful not to get swept up in the frenzy of social coupons. As some small businesses have learned the hard way, running a deeply discounted deal can give you so much traffic, and so many customers, that it will cost you money--a lot.

Portland, Oregon-based coffee shop Posies Café is one of those businesses. Owner Jessie Burke penned a revealing blog post about her café's losing more than $8000 from its Groupon promotion. Posies Café faced rude customers and overwhelming traffic -- all at a price that barely covered the base cost of the food being sold.

Posies Café is not alone. A recent study by Rice University surveyed 150 small to midsize businesses that had used Groupon, asking about their social-coupon experience and whether they would use the service again. While 66 percent of the 150 respondents said that their Groupon deal was profitable, a significant 32 percent found it unprofitable. And 40 percent of the respondents said they would not use Groupon again -- notable, considering Groupon claims that at least 95 percent of its sellers request to be featured again.

Before you jump on the social-coupon bandwagon, make sure your business can handle it. Here are five Groupon nightmares that could happen to you -- and how to avoid them.

Nightmare 1: One-Time Customers
A one-time customer who buys nothing extra is the worst situation for a small-business owner, because you're basically giving your products or services away for free.

Be prepared: Many Groupon customers are in it for the deal -- with no intent to come back or to purchase more than the coupon is worth -- so you should set up your store or business accordingly. Prep your salespeople to bring their A game and to sell extra products to customers aggressively; if you aren't selling more than what the coupon is worth, you are losing money. Service-oriented businesses might consider offering an incentive for customers to sign up for another appointment on the spot.

Collect e-mail addresses: Because of Groupon's privacy policy, Groupon cannot give businesses the e-mail addresses of the users who purchase Groupons. E-mail marketing is a valuable way of keeping in touch with your customers, however, so now is the time to implement an e-mail list. The easiest way to do this is to request an e-mail address at the time of the transaction (note, though, that it is illegal to require an e-mail address), or to put an e-mail sign-up list near the register.

Nightmare 2: Bad Branding
Offering deep discounts on your products and services can be a bad thing for your company.

Consider your size: What type of business do you have, and how many people can you reasonably serve? If you're a small salon with five chairs, for example, do you really need to open up your business to 500,000 potential customers? Consider Blo, a small salon and day spa in Chicago. Its Groupon promotion ($40 for $110 worth of services) sold 3915 Groupons in April. Unfortunately, that was way more traffic than the salon could reasonably handle, and its Yelp reputation consequently suffered.

Consider your product: Offering a deep discount on a high-end service or product can hurt your business. Bargain hunters are unlikely to come back and purchase your products at full price (especially if you offer a great deal), and you're devaluing your product in the eyes of your regular customers. A small, exclusive boutique won't benefit from 600 new customers who now think of the store as a discount brand.

Nightmare 3: Scheduling and Customer Overload
One of the biggest problems for small businesses using Groupon is the sheer number of customers Groupon might end up sending them. It's important to be prepared for the extra traffic.

Clear your schedule: Expect to be serving Groupon customers -- and only Groupon customers -- in the week following your promotion, beginning with answering phone and e-mail questions the day of the promotion. Consider hiring extra employees for the first few weeks of your deal, and designating someone to monitor the message board for your Groupon promotion.

Prepare your website: Contact your Web hosting company and make sure your site will be able to handle the extra traffic (Groupon suggests at least five times the normal volume) during the first few weeks after your promotion runs.

Cap the deal: One of Burke's issues with how Groupon worked for Posies Café was that Groupon didn't allow her to set a cap on the number of Groupons to be sold. Groupon responded to her blog post with a post of its own, saying that it has always been Groupon policy to allow merchants to cap deals. Use a deal cap to control the flow -- and if you come across a social-coupon site that will not permit you to put a cap on your deal, step away.

Nightmare 4: Consumer Bullying
Because a lot of Groupon buyers are deal hunters, some will likely try to muscle their way into even deeper discounts. Some customers will go beyond just being rude -- they'll lie, try to reuse coupons, or attempt to use multiple coupons on one trip.

Stick to the fine print: Don't bend the rules for any customers, even if they're regulars. Not only should you not have to (regulars should realize that they're getting a good deal on something they already purchase at full price), but a blanket policy will make dealing with hustlers easier. Fara Heath, owner of Portland, Oregon-based music school Sound Roots, ran a promotion with LivingSocial in September. Numerous people called her to try to bend the rules, but she told her manager to say, "This is a very good deal, and take it for what it's worth. Period."

Know your state laws: Some states say that it is illegal to put expiration dates on what are essentially "gift cards." (Groupon's terms of service require that merchants honor coupons for their face value for up to five years after the promotion runs.) Some states also require that merchants give cash back if a customer redeems a coupon for less than what it is worth (for instance, if a customer purchases a coupon for $20 and then buys only $10 worth of product, they may be able to ask you for a cash refund of $10).

Use Groupon's redemption tracking services: The best way to avoid repeat coupon use is to use Groupon's redemption tracking services to monitor what coupons have been used. This may take a little extra time at the register, but it's worth it.

Nightmare 5: High Redemption Rates
The ideal Groupon experience is this: Your small business runs a Groupon offer, people purchase thousands of coupons, and virtually none of those people redeem them. Not only do you get to keep your half of the money, but you also don't have to give away any goods or services at a deeply discounted price.

More realistically, between 60 and 80 percent of Groupon customers will redeem their coupons before the expiration date. Of course, it's possible (though unlikely) that you'll have a 90 percent or even 100 percent redemption rate.

Do the math: It's important to be prepared for a very high redemption rate -- so before you decide to run a Groupon promotion, do the math and make sure you'll still be in business if every Groupon user redeems their coupon.

If you don't already have a decent idea of how much "free" services or products actually cost your business, consider the ratio of your marginal costs to total revenue for a given month (or some other period).

For instance, if each $100 in revenue results in $40 of marginal costs -- which should not include fixed costs such as rent and employee wages -- then you can assess the cost of giving away $nof "free" goods or services as 40 percent of n.

For example, let's say your Groupon promotion costs $25 and allows the customer to purchase $50 worth of merchandise. If your customers come in and "spend" that exact amount -- meaning that they purchase exactly $50 worth of merchandise but spend $25 -- your estimated marginal cost is 40 percent of $50, or $20.

Your revenue appears to be $25, but don't forget that Groupon takes a cut of this -- most likely half, or $12.50, so your revenue on this purchase is actually $12.50. On this transaction as a whole, your business would lose $20 minus $12.50, or $7.50.

Now you can figure out what your business will lose in the worst-case scenario: A 100 percent redemption rate, with every customer spending the exact amount of the coupon. Multiply your total loss for each transaction ($7.50) by your Groupon cap number. If your cap number is 1000, then your business could potentially lose as much as $7500.

If this a larger hit than your business can reasonably take, either refigure the Groupon deal or step away.

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